Strong Commercial Mortgage Performance to Continue for U.S. Life Insurers

Fitch Ratings expects relatively stable commercial real estate fundamentals to drive strong investment results for U.S. life insurers over the next 12 to 24 months. Loss experience on life insurers' mortgage loan investments has been very favorable over the past year as evidenced by low credit impairments and a low percentage of troubled mortgages.

The overall credit quality of performing mortgages remained high, with 61% rated NAIC CM1 with strong credit metrics and 34% rated CM2 with adequate metrics. Favorable credit metrics have benefited from a stable economic recovery in recent years, generally modest levels of new construction, and low interest rates.

Key credit concerns include more aggressive underwriting in the hotel and multifamily sectors, which are further along the commercial real estate cycle, new construction in certain markets, retail properties with anchors facing performance challenges, increased exposure to single tenants in commercial mortgage-backed securities (CMBS) and a continued increase of interest-only (IO) loans as a percentage of total loans.

Investment in mortgages grew 8.4% in 2017 to $422 billion for life insurers in the Fitch's rated universe, which remained strong relative to the prior-year growth rate of 7.5%. Investment in mortgage loans over the last three years for life insurers were above historical growth rates for the industry as life insurers continue to increase allocation to less liquid asset classes in search for yield. Fitch expects this trend to continue over the near term.

Approximately 85% of life insurers in Fitch's rating universe saw growth in their mortgage portfolio last year. Mortgage allocations of life insurers for the industry have largely grown above historical allocations of between 8% and 12%. Average allocation was 12.3% at year-end 2017 with over half of life insurers' mortgage allocations coming in at 12% or above. Approximately one in five life insurers in Fitch's universe had mortgage allocations of 17% or above. Fitch views these allocations to be above-average and potentially more vulnerable in a declining real estate scenario.

Over 2017, the companies with the greatest year-over-year increases in mortgage loans were a mix of relatively newer entrants to the mortgage loan market and those that have had a long presence in the market. Growth in single-family residential mortgages, construction and land development loans, and multifamily mortgages outpaced growth in other mortgage loan sectors. Commercial mortgages continued to account for the majority of total mortgages at 73%, followed by multifamily mortgages at 14%.

Overall, life insurers' net investment in CMBS increased 2% at year-end 2017 to $124 billion (4% of cash and invested assets). However, unlike the increase in mortgage loan investments that was predominantly industrywide, the relative year-to-year change in CMBS investment was mixed at the individual company level as the net industry increase was driven by net increases in slightly above one-third of life insurer's in Fitch's universe. Nearly half of the life insurers had net declines in CMBS exposure in 2017.

The real estate sector fundamentals continue to build on the positive trends observed in recent years. However, certain markets with significant exposure to oil and gas or large amounts of new construction could face challenges in the coming years.